The unknown Asian dividend story

In the current investment climate many investors are expecting an interest rate rise announcement from the US Federal Reserve (Fed) possibly as early as September, which many believe will hurt the appeal of dividend-paying stocks.

However, this assumption ignores the positive longer-term dividend story in another part of the world: Asia. The long-term investment case for Asia is well-documented:

Favourable demographics

Rising levels of urbanisation

Increasing investment in infrastructure

A burgeoning consumerist middle class

All of which are contributing to the region’s strong long-term economic growth. While the story behind continued capital growth from Asian stocks is well-known, the dividend story is perhaps less so.

Income attraction

Despite the potential US rate rise, we believe the long-term case for investing in Asian dividend stocks remains strong.

First, dividend returns in Asia are highly-correlated to economic growth and account for over three-fifths of long-run equity returns (with capital appreciation making up the remainder).

For an active manager, the case for income in Asia is also supported by how the region compares favourably in its share of higher yielding (+4%) stocks in relation to its global market capitalisation weighting (see below).

Corporate governance and the levels of payout ratios in Asian countries also yields a positive correlation; companies with strong governance (in places such as Hong Kong and Singapore) look to create long-term shareholder value, while companies in countries such as Korea – where family-owned “chaebols” dominate – have lagged in this respect, with much lower payouts.

Furthermore, despite the compression we have seen on yields in the bond and money markets, dividend yields on equities remain at around their 10 year pre-financial crisis averages in spite of their potential for dividend growth.

Rate Risk

Although markets are focused on the potential rate rise from the Fed, the crucial factor to watch will be how fast rates rise from there.

In this respect, we think rates will rise gradually and this should make the transition to a normalisation of rates more manageable for income-yielding stocks.

Having said that, we do see some stocks in the more defensive sectors, such as consumer staples, utilities and healthcare, being more at risk from a rising rate environment given many appear relatively fully-valued versus the rest of the market.

Asian context

Although Asian stockmarkets have lagged global markets’ returns, this underperformance has come despite Asian companies having a broadly similar earnings profile to their global peers.

While valuations in other markets have seen a rerating upwards, Asian markets have not.

The China story

In part, sentiment remains relatively negative owing to the slowdown being seen in China.

Here, for producers, deflationary forces remain entrenched and are exacerbated by the elevated level of the currency.

Domestic corporate earnings remain under pressure and we are sceptical whether financial engineering will feed through to sustainable growth.

Governments and policymakers are in a better position to deal with any fluctuations in exchange rates.

Furthermore, structural issues such as debt and blatant overcapacity in the system continue to hinder growth.

This backdrop, unsurprisingly, has led us to avoid large parts of the market including a number of the financials there, in particular the banks.

Falling commodity prices

The current global situation – where oil is hovering around $50 a barrel – also favours much of Asia, which is a large net oil importer.

This is particularly beneficial to countries such as India and Indonesia, where inefficient fuel subsidies previously led to large current account deficits.

Falling commodity prices should benefit the region both from a macro perspective and a micro one with falling input costs for companies and improved spending power for the consumer.

Thus far there has been relatively little evidence of an improvement in domestic economic conditions as monetary conditions have remained relatively tight as economies brace themselves for September’s possible rate hike.

However, in contrast to the ‘taper tantrum’ of 2013, though, the region’s economies are in better shape to weather the volatility given the general improvement in their external accounts.

In Asia, the overall long term picture for investing in the region remains as strong as ever.

Current account deficits have fallen in countries such as India and Indonesia and most of the debt held by companies are denominated in local currencies; a far cry from the days of the 1997 Asian Financial Crisis when Asian companies’ succumbed to the weight of US-denominated debt that built up on balance sheets following sharp falls in their currencies at a time when many countries ran substantial current account deficits.

This time, governments and policymakers are in a better position to deal with any fluctuations in exchange rates and spending and to an extent expectations of a rate hike are more widespread now than then were in 2013 when talk of ‘tapering’ shocked the market.

On the global front export demand from Asia has been subdued versus previous cycles but any pick-up in growth globally will support earnings for Asian companies as the region remains the world’s factory.

In aggregate, valuations of Asian markets continue to trail those of the rest of the world reflecting the low expectations for growth in the region versus elsewhere.

In Asia, the overall long term picture for investing in the region remains as strong as ever.

And in a world where interest rates are still low, and with inflation rates on the cusp of deflation in many of the world’s developed economies, investing in dividend stocks offers investors both a relatively attractive income stream and potential for long-term capital appreciation.

As always, we maintain a disciplined bottom-up investment view and continue to look for good companies where we see a strong income case and potential for capital growth.

Topics:

Important Information: The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.
To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.

Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal.

To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada.